Will Congress Contain Medicare's Exploding Costs?

ROBERT
MOFFIT : Recently, David Walker, the Comptroller General
of the United States, noted that the official debt of the United
States is more than $7 trillion, which is about $24,000 for every
man, woman, and child in America. Mr. Walker told the National
Press Club, however, that if you count the unfunded liabilities--in
other words, the promised benefits of entitlement programs,
including the new $8 trillion unfunded liability on the
prescription drug benefit alone--you are talking about $42
trillion, equal to about $140,000 for every man, woman, and child
in America.

Medicare is the toughest problem
substantively. It is also the most difficult problem politically.
The question is: Can Congress contain those costs? Will Congress
contain those costs? How can Congress contain these costs? We have
a distinguished panel of former Congressional Budget Office (CBO)
officials with us today. They are going to try and answer these
tough questions.

Our
first speaker, Joseph R. Antos, is the Wilson H. Taylor Scholar in
Health Care and Retirement Policy at the American Enterprise
Institute. Joe is also an adjunct professor with the School of
Public Health at the University of North Carolina. He was
previously an assistant director for the CBO. Joe was also a staff
economist at the Council of Economic Advisers and a senior
economist at the Office of Management and Budget (OMB). He got his
bachelor's degree in mathematics at Cornell University and his
Ph.D. in economics at the University of Rochester.

Our
second speaker is Jeff Lemieux. Jeff is the founder and executive
director of Centrists.org, a new think tank in Washington with a
decidedly "moderate" ideological stance on public policy issues. He
is the author of a number of pieces about Medicare reform, balanced
budget issues, and entitlement spending. In the area of Medicare
reform, Jeff served as a senior staffer with the National
Bipartisan Commission on the Future of Medicare, headed by Senator
John Breaux (D-LA) and Congressman Bill Thomas (R-CA). The
Commission produced an enormous body of analytical work on the
Medicare program and its future. From 1992 to 1998, Jeff also
served as a principal analyst at the Congressional Budget Office,
where he helped to project costs for health care reforms, including
the changes in the far-reaching Balanced Budget Act of 1997. Before
his service at CBO, he was with the Office of the Actuary at the
Health Care Financing Administration, the agency now known as the
Centers for Medicare and Medicaid Services (CMS).

Finally, we are joined by Dan Crippen, the
former director of the Congressional Budget Office. Dan was a
domestic policy adviser to President Ronald Reagan and he also
served as the chief counsel and economic policy adviser to Senate
Majority Leader Howard Baker (R-TN).

JOSEPH R.
ANTOS : David Walker is a great Comptroller General, but
he is a little conservative in his estimates. He recently estimated
that the drug benefit would cost $8 trillion over the next several
decades. That is an understatement. My former colleague at AEI,
Jagdeesh Gohkale, estimates that the Medicare drug benefit will
have an unfunded liability that is more like $13 trillion. That
assumes that things proceed along in a normal fashion without
Congress expanding the Medicare benefit.

Can
Congress contain Medicare's explosive growth? There is a 39-year
track record on this question and it does not look too good. One
thing is clear: The answer to getting control over the excessive
spending in the Medicare program is not to keep doing the same
thing that we have been doing. It is to do something else.

I
think that the proper focus on Medicare costs should be the whole
program, not just drug costs. However, there has been quite a mania
here on Capitol Hill surrounding prescription drug costs and
thinking those are the problem. Certainly, adding a big, expensive
drug benefit adds to the overall burden of the taxpayer, but the
broader program is also on an unsustainable path. There are
obviously very positive aspects to covering prescription drugs in a
modern health insurance program. Unfortunately, Medicare is not a
modern health care insurance program. That is a major problem in
itself.

Drug Cost
Estimates. Let's talk about drugs. The recent debates
focused on what the Medicare Modernization Act (MMA) would cost. We
think we know the numbers--$395 billion coming from CBO, which is
the only relevant estimate when it comes to congressional
deliberation. The OMB estimate that came out in January or February
was $534 billion. Yet that is the wrong perspective. Comptroller
General David Walker, the head of the General Accounting Office,
was reaching for the right number. The new benefit is a permanent
entitlement: It is not going to stop in 10 years. This is a
permanent commitment of resources on a massive scale to pay for
prescription drugs under Medicare.

One
might ask how much Medicare is going to spend on drugs alone,
because there are other things in that bill. If you look carefully
at CBO's November 20, 2003, letter to Senator Don Nickles (R-OK),
you can find the answer. What you see is that there are three
drug-spending components in the bill--not counting Part B drugs,
and apart from the new Medicare discount card.

What
are the three components of the 10-year CBO estimate? Benefits
amount to $507 billion, which is money spent primarily through the
prescription drug plans or through the new Medicare Advantage plans
that will offer a drug benefit. Next, there is an employer subsidy
of $71 billion to support drug purchases. Finally, there is a
low-income subsidy of $192 billion. Note that this is not a payment
to people: It is a payment to drug plans. That money might, in
fact, go to any of the sponsors of drug benefit programs. When you
add up all of these numbers, you get $770 billion in total federal
spending for prescriptions under the new drug benefit.

There are some offsets. Only one offset
directly relates to purchasing prescription drugs, and that is the
amount of premiums paid by beneficiaries enrolled in the drug
benefit. Those premiums come to about $131 billion. You could think
of that as beneficiaries paying back some of their drug benefits.
If you look at it that way, total federal spending for Medicare
drugs under the benefit may be $640 billion instead of $770
billion.

Two
other big offsets literally have nothing to do with buying
prescription drugs for people in the Medicare program. They include
$88 billion that the states will kick back to the federal
government. That is not Medicare money. That is actually Medicaid
money. In addition, Congress reduced federal Medicaid spending by
$155 billion. This is the result of shifting dual-eligible persons
from Medicaid to Medicare for their prescription drugs.

What
is the real number? It might be $400 billion; it might be $500
billion; it might be $800 billion; and it might be $13 trillion in
promised, but unfunded, benefits over the long term. Whatever the
total might be, it is an unlimited amount because this is an
entitlement.

Cost Containment
Provisions. What about "cost containment" in the new
Medicare law? I put cost containment in quotes because there really
is no cost containment provision in the cost containment title.
There are cost containment elements in the bill, just not in the
section labeled "cost containment." There is the trigger provision:
Congress and the President are supposed to take action when general
revenues exceed 45 percent of total Medicare outlays. Congress has
decided that that is an indication that Medicare is in serious
financial trouble, and the level of general revenue financing will
be predicted by the Medicare trustees.

They
will look out over the next seven years and if they see that
general revenues will account for 45 percent (or more) of Medicare
outlays, they will serve notice. If they see that problem two years
in a row, they will issue a Medicare-funding warning.

What
is supposed to happen as a result? The President, by law, is
required to submit proposals to Congress to address the issue.
However, those proposals might not reduce excess spending. The
proposals could increase revenue, decrease spending, or go the
other way. On balance, it is not entirely clear what the President
must propose, but he has to propose something.

Although Congress wrote in some expedited
procedures for consideration of these presidential proposals, it is
not obligated to do anything. At least from a political standpoint,
this is a good cost containment provision because there is no
political harm in it--at least not immediately.

How
quickly will we see a warning from the trustees? This year's
Medicare trustees' report projects that 2012 will be the first year
that we hit the 45 percent level of total Medicare spending from
general revenues. It could happen sooner. Our first notice that
this is a problem may be given in next year's trustees' report. The
year after that--if they are right about this--we will have our
first official funding warning and then we will have such a warning
every year for the rest of our lives.

Old Medicare
Strategies. Let's talk about how you put a lid on Medicare
spending. Essentially there are three ways that people have thought
of to do this. The first way--the traditional method for
Medicare--is to put tight limits on payments for individual
services. We have used this approach over the last 30 years or so,
and some argue that it has been effective. However, it is not
permitted for prescription drugs by the Medicare Modernization Act.
Under the new Medicare law, the Secretary of Health and Human
Services is not allowed to directly negotiate drug prices with drug
companies. The Secretary is supposed to let private competing plans
do the negotiation: He or she is not supposed to interfere. The
bill did not fundamentally change anything about importing drugs
from foreign countries. Therefore, at least as the bill is written,
that is not an option.

I do
not think that Congress will seriously consider re-importation in
2004--and probably not next year, either. However, time is
young.

The
second method of limiting costs is something some fiscal
conservatives wanted to see in the bill. Why not just cap overall
Medicare spending? A number of people have been thinking about this
and we are liable to see yet another proposal come down the
road--possibly from Senator Judd Gregg (R-NH)--sometime later this
year.

Finally, we come to the only way that, in
my opinion, really works: market-based Medicare reform. Improve the
efficiency of the delivery system. That is hard work. It is not an
easy political fix, but it is what we have to do.

Spending
Caps. Before I get into that, however, I want to say a few
negative things about spending caps. I do not believe in them. If
they were effective, they would do more harm than good. Go back
through the track record on these budget gimmicks--it hasn't been
very good. The Gramm-Rudman-Hollings Balanced Budget and Emergency
Deficit Control Act of 1985 is an example. That act was an attempt,
government-wide, to limit the growth in federal spending. It
basically did not work and it fell into disuse. On the other hand,
one might call the sustainable growth rate formula for physician
payment in Medicare a success. That has been effective, to the
dismay of many members of Congress who voted for it.

There are real downsides to spending caps.
The sustainable growth rate formula for physician reimbursement
illustrates the problems. In 2002, CMS took a 5.4 percent
across-the-board cut on physician fees. There were all sorts of
complaints from physicians. In some parts of the country there were
reports that Medicare beneficiaries were having trouble getting
appointments with specialists or providers other than their family
physicians.

However, the physician caps did not work
in a more fundamental sense. Spending grew by $3 billion in
physician payments that year. If you talk with the Medicare
actuaries, you know that this is remarkable, and it was likely
driven by a big increase in the volume of physician services in the
Medicare program. You can cap certain things, but you cannot
control behavior. That is one of the lessons.

Caps
do not provide lasting cost containment, but they can cause
enormous political problems. I think Congress is going to endure
those problems for many years. The budget rules make it difficult
to change.

The
Balanced Budget Act of 1997 succeeded in cutting Medicare spending,
mainly through cuts in provider payments. Those cuts helped to
drive managed care plans out of Medicare. If payment cuts were
effective, you could have this same effect again, particularly with
prescription drugs and private plans. Cutting back capitation
payments by 30 percent is probably not the way to encourage private
entities to participate in the program. We did it in 1997, 1998,
1999, and so on, and we could do it again.

Finally, how do you weigh immediate budget
savings against the future cost of forgoing some research and
development--and potentially forgoing the creation of useful new
drugs? There are all sorts of views about the pharmaceutical
industry and research, but economists agree that if you severely
cut back the profit potential in any industry, the innovators in
that industry find someplace else to put their money.

What
can we do about rising Medicare spending? We have to do the hard
thing. We have to make structural changes to improve the system's
efficiency. Fortunately, the Medicare Act does have some components
of meaningful cost control. There is more competition in the
Medicare program because of this bill than there has been to date.
We will see how that works out because there are problems, but
nonetheless, there is a chance to see effective competition under
MMA.

Moving away from the adjusted average per
capita cost as a system of paying health plans and setting rates on
the basis of competitive bids is a giant step forward in thinking.
Yet again, we have to see how that is going to work out in its
implementation.

Finally, there are some small initiatives
that begin to get at the heart of health care delivery, which is
what we ultimately ought to be concerned about. These are disease
management, quality initiatives, information technology, and value
purchasing. My concern is that these have already become political
buzzwords as opposed to the real thing. These ideas are not quick
fixes. These are good ideas that need to be developed into
effective measures. That is going to be tricky in the context of
the existing Medicare program, but these are good things to do and
to promote.

Real
Reform. What else can we do? What else must we do? The
answer: what everybody has talked about for the last four years.
The Federal Employees Health Benefit Program (FEHBP) should be
adopted as a model for a new Medicare program.

The
payment formula in that model does something that the Medicare
Modernization Act doesn't succeed in doing: It puts a limit on
federal spending, but in a sensible way. That limit recognizes that
health care costs do rise even in an efficient system. It does not
penalize beneficiaries dollar-for-dollar just because the inherent
costs of health care have gone up from one day to the next. This is
a problem with some versions of defined contribution plans in
health policy. We have to allow reasonable growth for reasonable
expenses, but we do not want to remove the incentives for plans and
providers to try to do a better job in serving Medicare
patients.

The
FEHBP program does that. It offers consumers realistic choices, not
promises that ultimately cannot be kept. That is where we are in
Medicare today. We need to solve this problem, and there is a
time-tested way to proceed.

JEFF
LEMIEUX: Let me tell you a personal story of how even the
best-intended price controls can go awry. When I was at CBO, I was
very closely involved with the development of the sustainable
growth rate (SGR) formula for updating physician payment in
Medicare. Through that formula, we tied updates in physician
Medicare payment to a set of variables, including the growth in the
economy. It was a real eye-opener. It was the staffers at the
Committees on Ways and Means and Senate Finance who were the key
innovators. However, I was the one who had to do the estimate for
that SGR. I think I got the estimate basically right. I said, at
the time, it would save some money. Yet all I was thinking about at
the time was the estimate of savings, not the possibility that the
SGR system could be very volatile. What I did not say was that it
would cost a lot of money in a few years and then save a ton of
money a few years after that. We predicted much too smooth of a
curve and did not predict the political fallout that would occur
when doctors saw big rate cuts. That was a lesson to me. When
Congress tries to control costs in Medicare, it can, but in the
long run it can also be very difficult.

The Role of
Private Health Plans. I would like to say a few words
about the budget situation and Medicare spending growth, and then
discuss how price controls can go in unintended directions. Third,
I'll say a few words about private health plans and competition in
Medicare, and how policy misconceptions can have unintended
consequences. Next, I will say a few words about a theory that I
have been trying to develop about how private plans can form a
political alternative; and examples for how Medicare can evolve and
possibly save money--even if they do not necessarily save money on
Medicare in a strict formulaic sense. Finally, I would like to say
a few words about the discount card, which affords some hope as a
model for controlling Medicare costs.

First, let's talk about the federal
budget, the surplus or deficit: The latest projections are that the
federal deficit is going to be about $440 billion this year. That
is almost 4 percent of gross domestic product (GDP). It will
probably range somewhere between 3 percent and 3.5 percent of GDP
for the next several years as the economy recovers. After that,
things just go downhill.

If
we have an extension of the tax cuts, which I am assuming, and we
do not add any new spending or any particular spending cuts, the
deficit stays within a workable range--not a good range, but a
workable range of 3 percent to 4 percent GDP for the next several
years. However, as the Baby Boomers start to retire and really kick
in the Medicare and Social Security spending, the situation becomes
completely untenable.

There are four big entitlements, and
Medicare is only one of them. Social Security is going to grow by
about 2 percentage points of GDP over the next 25 years, Medicare
by a little more than that. Medicaid has really become a long-term
care program and a program for disabled people. As you can see, the
long-term prospect is that Medicaid is going grow very rapidly if
it stays under its current structure.

Finally, there is the entitlement that
conservatives always forget about--interest. We pay interest on the
national debt. That spending entitlement has shrunk the most in the
1990s as we switched from budget deficit back to surplus, as
interest rates fell, and especially with the start of the recession
in 2001. Now that the economy is recovering, interest rates are
going to increase and we are tacking on debt of over $400 billion
per year. The "interest entitlement" could conceivably become our
largest entitlement after 2030. If we do not start to control our
deficits, we are going to have a major entitlement problem on our
hands.

Medicare spending is growing pretty fast,
with double-digit rates in the early nineties. In the mid-1990s, we
started passing anti-fraud measures, which had a pretty big
impact--a bigger impact than a lot of people expected. There was
some over-billing in some hospitals. The growth in Medicare
spending started to come down.

The
Balanced Budget Act of 1997 (BBA) caused the growth of Medicare
spending to fall a lot in conjunction with the anti-fraud measures.
Some of the BBA cuts were more than providers could swallow and we
started to give back money in the late 1990s and the beginning of
this decade. Medicare spending is expected to stay under 7 percent
for another year or so. Then the Medicare Modernization Act really
begins in 2006 and there will be a big spike in the growth of
Medicare spending.

We
are growing the Medicare program as an ever-larger percent of GDP.
This process is accelerating with the Medicare Modernization Act of
2003.

Price Controls.
Price controls will not be a very durable way to control
Medicare spending. It is exactly like the physician fee debacle
that we just discussed. The formula gave physicians some pretty big
raises right after we implemented it and that caused physician
spending to go really high. Yet we also included in the formula a
hard cap on physician spending and once we hit that cap the
physician fee updates were scheduled to be negative for almost a
decade.

Measured as dollars per unit of service,
the physician fee schedule will go from in excess of $36 to under
$28 by the time that the Baby Boomers are well into retirement. Of
course, what Congress is going to do is fix this each year. Yet
throughout the course of this next decade, it could easily cost
$120 billion to $150 billion to fix.

Congress fixed the Balanced Budget Act of
1997 for a little while and that cost us some money. However, it
also saved us some money in the "out years" because Congress did
not really fix it. They just kicked the problem down the road,
which actually made the physician fee cuts worse a few years
later.

The HMO
Issue. I would like to address briefly Medicare health
maintenance organizations (HMOs). We had a big boom in Medicare HMO
enrollment in the mid-1990s to late 1990s. Actually, after the
enactment of BBA, HMO enrollment started to fall at a pretty rapid
rate.

We
have often been told by health policy experts that Medicare HMOs
get the healthiest seniors; therefore, they are costing the program
a lot of money. By that theory, when Medicare HMO enrollment went
up a lot in the late 1990s, you should have seen Medicare spending
go up because you are taking healthy people out of the traditional
Medicare fee-for-service program--the very people who didn't cost
us anything--and putting them into an HMO in which we are paying a
capitation rate that is very close to the average Medicare spending
and vice-versa: Once Medicare HMOs almost started to fall after the
enactment of BBA, the logical thing that you would expect to see
would be overall Medicare spending starting to fall.

The Big
Surprise. It did not look like it really worked out that
way. When the growth of HMO enrollment jumped up into the 20
percent range, Medicare spending started to trend down. When the
growth of HMO enrollment turned negative in about 2000, that was
roughly when Medicare spending started to come back up.

Of
course, there is more going on here as we have already heard. There
are the budget cuts, the givebacks, and all sorts of things. Yet
all other things being equal, we would have expected the opposite
of what did, in fact, happen. It is hard for me to imagine that the
Medicare budget cuts and then the Medicare " givebacks" were so
powerful that they could have negated the predicted theoretical
outcome that so many health policy experts expected. Therefore I
concluded that perhaps the Medicare HMOs were not, in fact,
enrolling such healthy people. They might, in fact, be enrolling
people with normal healthiness or they may be enrolling
sicker-than-average people.

I
did a little bit more work trying to determine whether or not their
payment rates have changed corresponding to Medicare
fee-for-service, and it turns out they have. After 1997, we
essentially paid private firms in Medicare about the same rates of
increase as the growth in fee-for-service spending. Yet it turns
out it was really skewed. In the plans where people actually
live--in the large urban areas--the payment rates have grown a lot
less and that is why you have seen such a decline in enrollment.
HMOs in areas where there are fewer people received the so-called
floor update. Those HMOs who received the floor update actually got
higher updates than Medicare fee-for-service.

In
the last several years, there have been more payment adjustments,
especially to some of the large low-cost urban areas, such as
Minneapolis and Seattle. We are paying HMOs about the same as we
paid them in 1997, but there has been this dichotomy on how we pay
them.

As a
CBO estimator, my theory about these HMOs is that if they come back
into the Medicare program as a result of the payment increases we
enact to bring them back up to par--as we do in the Medicare
Modernization Act--it will certainly cost us money. However, I also
have a theory that having a fairly large, workable, noticeable HMO
sector in Medicare causes Medicare administrators to think very
differently than when they simply operate the traditional Medicare
fee-for-service program. Suddenly there is an example out there of
people doing things differently. If you see a big surge in
enrollment into this alternative sector--as we did in the
mid-1990s--I think that caused Medicare administrators to take
notice and to try to find ways to ratchet down Medicare
fee-for-service spending in order to make Medicare fee-for-service
more efficient.

The
fact that a lot of these Medicare HMOs have drug benefits really
caused politicians to ask, "Why doesn't Medicare have it? Shouldn't
we do something about this to modernize the program?"

I
think, both in terms of keeping the benefits up to date and in
terms of cost control, having this alternative sector out there is
very helpful to the Medicare program. I am somewhat optimistic that
the MMA has brought HMO payments back up to par--back up to where
they were in 1997. I think this will cause more HMOs to come into
the program. There is a provision in the bill to try to bring more
preferred provider organizations (PPOs) into the program, but
sometimes laws that we pass have the opposite effect of what is
intended. Yet I think this one probably does have a chance to bring
more of the "less-managed" HMOs into the program and I think that
will be very helpful.

I
don't predict that HMOs and PPOs are going to take over the program
or come to anywhere near 30 percent or 40 percent of market share.
It may be 20 percent or 25 percent over the next several years or
the next decade. Yet it will be very helpful to have that robust
alternative program out there for us to look at and to learn from
as we continue to work to improve the program.

The Potential of
the Drug Card Finally, my only other source of hope about
Medicare spending is this drug discount card. You have probably
heard from the critics that the seniors are calling up saying, "It
is too confusing on the Web," and "I couldn't get through to
1-800-MEDICARE," and "There are so many choices. What am I going to
do?" Those are all valid concerns. There are some parts of the new
Medicare law that were drafted poorly. I don't understand why they
lock seniors into one card until the next open enrollment period.
It makes no sense at all.

That, of course, causes seniors to think,
"This must be a very serious choice." I initially couldn't get my
mother to sign up. She is age 66 and pretty Web-savvy, but she
could not get through the bit where you had to type in all your
drugs. She just did not want to give the government that
information, I guess. Yet she finally called 1-800-MEDICARE and got
a card. I said, "Which card did you get?" She said, "I got a card
that I have to drive all the way down to Wal-Mart [to use], but
it's a dollar cheaper per month than the CVS card that's right next
to where I live." That's interesting.

All
told, it took a month to get her enrolled in this thing. She is
saving $45 per month at Wal-Mart when she would have been saving
$44 at CVS. Yet she spent all this time worrying about which card
she got. She could have picked any card and would have saved a fair
bit of money. She is not one of these people who shops smart and
gets on the Web and goes to Internet sites or anything like that.
It is those non-smart shoppers who save the most from the discount
card.

I
think this model is potentially a very good model. I think that one
of the problems we have (other than seniors thinking it's such a
serious deal) is that seniors think it is the final drug benefit
and the choice they make now is going to be with them for 30 years.
Then the enrollment is confusing. You have to find the right card.
You have to type in your drugs. It should be much easier. You
should just be able to make a selection at any time. Yet I think
one year from now, people are going to really start to like this
idea.

I
think that as the people in CMS and in Congress start to think of
it more as a public-private partnership that Medicare is promoting,
that will help a lot. The discount card provision has a chance to
be popular enough that when we implement the 2006 drug benefit,
ordinary people are going to say, "Now wait a minute. You guys have
finally got this discount card thing up and running and we like it.
It's saving us a lot of money, especially if we weren't very
careful shoppers before. Now you're telling me I have to go get a
new stand-alone drug benefit, and this time, it is kind of serious.
Instead of being free or essentially free, now I have to pay a
serious premium and there are serious implications to how this
reacts with my retiree coverage and other things."

New Options for
Drug Coverage? I think there will be political
groundswells to keep those discount cards going. We could perhaps
add to the low-income benefits and boost that amount above $600. I
would like to think that we could add a catastrophic benefit for
people who have devastatingly high costs. I think we are capable of
doing that through the drug discount card. It might be a lot less
traumatic than trying to switch to a whole new system with the 2006
benefit. Maybe you do both and give people the option. Do you want
to stick with a mostly free discount card with a few extra things
that we are going to put on it? Or would you like to pay a premium
and go to a more elaborate system and see how it works out?

My
fear--because you see how hard it is to get the discount cards
going--is that the big drug benefit will be harder. My fear is that
if the drug benefit's implementation goes badly, it gives this
whole idea of public-private partnership (and using the government
to put together better choices and efficient options for seniors) a
bad name or a black eye. I think that next year we need to be very
careful about writing new legislation to improve the discount cards
in order to smooth over the transition to this large drug
benefit--and make the discount card another option as part of the
process.

DANIEL L.
CRIPPEN: Let me begin by saying that we need to think
about an entirely new Medicare program. I recall something often
attributed to Albert Einstein. I'm not sure he ever said it--it
doesn't sound quite like him--but it goes like this: "The
definition of insanity is doing the same thing over and over and
expecting a different result."

That
is essentially what we have been doing with Medicare for many
years--trying to adjust provider payments--with ultimately little
to show for it. Although occasionally we have changed something for
beneficiaries, it has generally only been at the margins. In
neither case have these changes ended up providing much relief from
the inexorable upward spending imposed on the American taxpayers,
nor have they provided a comprehensive health benefit for our
seniors and disabled citizens.

We
had a budgetary aberration, a slight downturn in spending, in the
aftermath of the Balanced Budget Act of 1997. As Jeff said, there
are lots of reasons why that might have happened. It certainly has
not been a successful outing when it comes to controlling costs. On
average, since the inception of the Medicare program, per capita
real costs have grown much faster than the economy.

As
we come to the cusp of my generation's retirement, we will face a
doubling of the number of retirees for the program--from roughly 40
million to 80 million. Costs are obviously going to go up a lot
simply because of the raw demographics.

Yet
more important to the overall outlook for this program is this
underlying trend of Medicare spending that is growing much faster
than the economy. As Herb Stein might have said: This cannot go on
forever.

From
the very beginning of the program in 1965, we predicted that
hospital costs would come into line with wage growth and economic
growth. Obviously, it still has not happened. We are still waiting
for the lines to converge. However, I am very much afraid that in
the process of waiting, the current spending trends will have a
very detrimental effect on my kids and the generations to come.

A New
Paradigm. Some of you are old enough to remember that
there was a fellow who did a lot of work in the first Bush
Administration, Jim Pinkerton. He coined, or at least used the
phrase, "a new paradigm." It was a way of framing an argument for
major change. Certainly in the case of Medicare, we are due for a
new paradigm. I do not know if Pinkerton is available, but maybe we
can bring him back to give us a hand: Just don't tell Dick
Darman!

In
my opinion, too many commentators, too many pundits, and even too
many health care analysts are issuing pronouncements about what we
can do, how we can do it, and how much government policy or
spending can move things along without regard for the context of
the recent past and the foreseeable future.

Disappearing
Surpluses. First, there is the issue of available
budgetary resources. In that context it is instructive to ask where
the budget surpluses came from and where they went.

We
at CBO initially thought there were going to be surpluses for a
long time. Many people would like to claim that it was the dramatic
congressional actions taken in the late 1990s--the changes in
budget policy, including the BBA--that yielded the strong
projections of budget surpluses. In fact, the change in budget
outlook was not due so much to change in policy as it was to change
in the economy. The economy performed better than anybody expected
at that time. Also, the economy produced more revenues than anybody
expected or had seen in the past. That was due to the stock market
run-up, capital-gains revenues, and also stock options being cashed
in, which were taxed at normal rates (and for most people at quite
high rates). Therefore, the revenue increases were greater than you
would have otherwise expected. It was largely the change in the
economic performance and the production of revenues that caused the
change in outlook--not dramatic changes in legislation or
policy.

What
happened to the surpluses? The tax cuts, which are often blamed for
the entire change in the budget outlook, are certainly part of
it--particularly in 2003 and 2004--and they are significant. In
addition to the tax cuts, spending has grown rapidly, largely in
response to 9/11 and the war in Iraq. Yet there has been a myriad
of other spending increases as well, including Medicare givebacks,
tuition reimbursement, and other domestic discretionary spending.
In fact, spending is larger than the revenue changes in terms of
this altered budget outlook. Again, the economy is a major piece of
the budget story. What the economy gives, the economy can take
away.

In
the context of the economy, we can push our analysis back in time,
say, for 50 years or so, and examine our country's propensity to
"tax and spend." We have averaged about 18 percent of GDP as a
federal tax-take during this entire period. Obviously it has been
much higher in some periods--often the periods immediately before a
tax cut--and lower in others, but it is has oscillated around 18
percent for much of this period.

Looking to the end of this decade, there
is a chance that the economy, and therefore revenues, will grow
enough that we will get back to something close to balance. I am
not predicting that we are going to end up at balance, but we could
be within shouting distance of balance by the end of the decade if
the economy continues to perform, spending is held in check, and no
further tax cuts are enacted.

In
my analysis, I assumed per capita Medicare growth of 3 percent
after inflation and I incorporated a drug benefit that amounts to
about 1 percent of GDP. Therefore, growth should be a little higher
than the CBO assumption during this decade or during this period,
but not a lot higher. The punch line is that you get the 16 percent
or 17 percent of GDP by the end of the retirement of the Baby Boom
generation.

Tax
Bite. Therefore, if we continue to tax an average 18
percent or 19 percent of GDP--as we have since World War II--almost
all of that federal revenue would have to go to funding Medicare,
Medicaid, and Social Security. Put another way, we would have to
eliminate the rest of the federal government as we know it,
including the Defense Department.

Of
course, we could try to borrow our way out of this shortfall, but
it would mean essentially trying to borrow the equivalent of $1
trillion per year in current dollars. That amount would grow
dramatically simply because of interest costs and would quickly
outpace savings here and abroad.

We
could obviously attempt to tax our way out of this problem, but it
would take enormous increases, at least for this country. To
protect programs for the elderly and preserve our current level of
government spending on other programs would require a tax increase
of roughly 10 percent of GDP--ten times the size of the Bush tax
cut of 2001--or a payroll tax rate of 30 percent to 35 percent, for
example. By the way, if you decided to fill the financing gap by
raising payroll taxes to 35 percent, you would have a very dramatic
effect on labor supply, which would negatively affect the outlook
for the economy.

The Crisis Is
Now. It is pretty clear that in addition to borrowing or
taxing or cutting other spending, we need to spend a lot of time
thinking about these programs for retirees and the disabled and how
to reform them. We also need to think about reform regardless of
the status of the trust funds. While there has been much discussion
about Part A trust funds going belly-up or being insolvent in the
next decade, the real truth is that this year is the first year in
which payroll taxes will not cover spending for Part A, which means
the economic and budgetary consequences begin this year.

The
point is that we are going to have to supplement Part A payroll
taxes with real dollars. Those transfers may be called "interest
payments," but they are payments of general fund revenues, either
borrowed or taxed from the public. Eventually, there will be bonds
cashed in, which is a perfectly fine thing to do, but those bonds
have to be converted to cash and that cash has to come from
taxpayers in the form of general funds. Therefore, this year is when the real economic
and budgetary consequences start, not some future date of
"insolvency."

The
same point, by the way, applies to Social Security. It looks like
2019 will be the year when Social Security becomes
insolvent--certainly not 2052 or 2049 or whatever the projected
date may be.

In
the end, trust funds are irrelevant to our calculation of the
immediate impact on taxpayers and the budget. The trust funds do
not contain resources that can be tapped to reduce the burden on
the working, investing, and taxpaying population. In the main, the
working, productive population will have to finance the Baby
Boomers' public retirement, whether through taxes, borrowing, or
reduced spending on other programs.

I
should note another consideration here, the question of whether you
try to finance benefits by imposing more beneficiary charges or by
increasing taxes on workers. There are differential effects on the
economy, depending upon the level of intergenerational transfers.
Obviously, the more you use beneficiary premiums, the less you rely
upon current taxes and current taxpayers, and the less you will
have an effect on the economy (but never zero).

A
relative handful of the elderly expend the lion's share of Medicare
resources because they have the most health care needs. The top 20
percent of Medicare spenders account for 84 percent of the total
Medicare spending in a given year--25 percent of the beneficiaries
account for 90 percent of the dollars.

Smart
Card. With this distribution in mind, consider a new
paradigm, a new Medicare policy. Let's first make a distinction
between the 75 percent of Medicare beneficiaries who expend only 10
percent of the resources and rarely end up in the hospital, and the
high-cost beneficiaries. Take that 30 million people, give them a
budget, think of it as a dollar amount encoded on a smart card, and
let them spend it as they see fit. They could go anywhere they
wanted and see any provider to get their health care. They could
fill prescriptions with their smart card. They could see doctors
with their smart card. They could have lab tests or whatever
services or procedures they needed or wanted for their health care.
No matter how you see the program working, the simple truth is that
these 30 million beneficiaries do not spend enough, do not need
enough health care that we should follow them around with a
rulebook or require extensive reporting by providers.

You
could income-relate the amount of dollars loaded on each card. You
could vary the amount for patients with chronic diseases. You could
have co-pays for beneficiary incentives. You could do all those
kinds of things and more, but the point is you could cut loose
three-quarters of the Medicare beneficiaries and not worry about
controlling their behavior because they do not spend enough.

Focusing on
High-Cost Patients. That leaves us with the one-quarter
who do spend most of the money. What would we do about it? It turns
out we do not know much about these patients. The data that we have
is largely a mass of separate transactions. When my father sees a
doctor, it shows up as a Medicare record with payment and diagnosis
and other ancillary information. A lab test produces another
record. If he goes to the hospital, there is yet another record,
and until recently no one in the federal government added up what
he spends in a given year or over his lifetime. More important, no
one tracks what he is being treated for or what the outcomes of the
treatments are. It is simply a series of transactions. The bills
get filed and they get paid.

Fortunately, with Joe Antos's help before
he left CBO, and others since, we were able to assemble a first
dataset of some beneficiary-level data, by incorporating these
transaction records into monthly spending data for about 3 million
beneficiaries over the course of 12 years or so. It is not a very
satisfactory database. For one thing, it does not have any
pharmaceutical data: There hasn't been a pharmaceutical benefit in
Medicare. It is also difficult to use. The transaction codes, the
diagnosis codes, and the ICD-9 codes may be inconsistent or mask
several conditions. Therefore, it is not particularly good data,
but it at least provides some insight into these patients.

My
specific pitch today is that we ought to start a program of
collecting much better data, especially on these beneficiaries who
are sicker. That would mean going out with actual surveys and doing
medical abstracting, histories, lots of things. Pick a sample of
10,000 of these patients and really do a lot of work determining
their conditions, how they are being treated, and their medical
outcomes.

Given what we know, or are beginning to
learn, it is encouraging to think that we could do a much better
job of taking care of them and, at the same time, probably save a
lot of money in the process. If you look at these "big spenders"
you will find, for example, most of them go to hospitals at least
once a year--and often several times each year. If we could reduce
the admission and re-admission rates, we would likely produce
superior results at lower costs.

Think again about the 75 percent who do
not spend much money--some 30 million--with their theoretical smart
cards. That is their Medicare program until they require
hospitalization. However, once they enter a hospital, we are going
to take a much closer look, with much more scrutiny--intense
management, case management, or whatever you choose to call it.

By
the way, this is a case in which disease management as it is
currently practiced, while promising in some quarters, may not
yield much for this population. Many of the elderly and disabled
patients suffer from three, four, or five chronic conditions--in
particular, heart disease, diabetes, high blood pressure, and
chronic obstructive pulmonary disease. Therefore, how we treat
these specific diseases in the younger, commercial population, does
not necessarily apply to the elderly. For example, the drug
regimens for multiple conditions have not been developed and we end
up sending a lot of these people to emergency rooms with drug
interactions. We do not know how to treat these multiple conditions
very well.

We
do know some instructive things about this population, however. We
know they end up in hospitals repeatedly. We know from looking at
these data that many of them have 10 and 15 physicians--two
physicians for each of their conditions, a general practitioner and
an internist, for example. They fill over 50 prescriptions a
year.

We
know no one is responsible for coordinating this care. There is no
payment for coordination. There is no requirement for coordination.
In the best of circumstances, there is a good doctor out there
somewhere trying, or a good son or daughter, or the patient
themselves. At the same time, the more conditions these patients
have, the more likely it is they are also impaired mentally.
Therefore the more coordination they need, the more likely they are
to be unable to do it themselves.

With
apologies to Jim Pinkerton, to the extent I offer any kind of a
"new paradigm" for Medicare reform, it is that we need to think a
lot harder about these beneficiaries who need the most care. If you
look at populations that have similar, often multiple conditions,
like Medicaid in which there has been fairly intensive case
management, hospitalization rates have been cut by 20 percent to 50
percent. If we can manage to keep people out of hospitals, we are
likely to improve their health and substantially reduce Medicare
expenditures. The short, simplistic version of the new paradigm:
Keep Medicare beneficiaries out of hospitals.

There are other ancillary data to support
the notion that costs could be substantially reduced without
changing health outcomes. For example, Wennberg and Fisher found
substantial differences in the cost for Medicare beneficiaries from
Florida to Minnesota. While the practice patterns are different,
there are no differences in health outcomes, suggesting that if
Minnesota practice standards were used around the country, Medicare
costs could be reduced by 25 percent.

I
hasten to repeat that this is only suggestive. This is the basis
for some hope about a new approach and a whole new system that
separates the high-cost Medicare patients from the low-cost
Medicare patients. Most Medicare beneficiaries do not need
intensive management. Let them do their own thing--they do not cost
enough. Once they are hospitalized they could enter another, more
intensively managed program. Additionally, you would try to pick up
the people who were going to be expensive before they actually got
expensive, perhaps through some predictive modeling or
screening.

Physicals conducted upon entering the
Medicare program could also be a screening device. A physical would
help find diabetics, for example, and people with certain
"pre-existing conditions." Also, if we had appropriate modeling, we
could pick up people with a combination of factors and predict that
they are going to be severely ill. We could perhaps defer
expenditures, if not eliminate them.

Revolving
Door. There are pieces of this problem that could be
addressed without having the complete system developed. One of the
phenomena we noted in the CBO Medicare database is that we have a
revolving door of sorts between nursing homes and hospitals.
Elderly people in a nursing home get sick, are taken by ambulance
to an emergency room, and checked into a hospital. Doctors find it
better to treat them there. It is easier and they have the
facilities they need. There is not a separate reimbursement for
physicians to treat patients in nursing homes. Therefore, the whole
system promotes moving them from a nursing home into a hospital.
After some days of treatment, they go back to the nursing home.

It
is not uncommon to see some of these people revolve in and out of
nursing homes and hospitals a number of times in a given year.
True, it is a small part of the high-cost population, but a
manageable piece you could analyze and work on. Another piece of
the puzzle is the treatment of people at the end of their lives.
About 20 percent of Medicare expenditures every year are for people
who do not live through that year. Examining how they are treated
is another way of thinking about a subpopulation of these expensive
patients. It is encouraging, although perhaps not surprising, that
many of the elderly want to die not in a hospital, but at home.
However, many still end up dying in a hospital. There may be a way
to better facilitate their desires.

Finally, I want to mention one small
silver lining to this Medicare cloud. If you accept the premise
that we need to keep people out of hospitals, and could devise a
strategy that would cut hospitalization by half, you might worry
about the consequences for hospitals. Yet the coming retirement of
my generation is going to double the Medicare population, leaving
hospital utilization unaffected overall.

Share

To develop true Medicare reform, the Administration and Congressneeds a clearer set of illness-specific, beneficiary-leveldata-particularly for the oldest and sickest Medicare patients.This will enable Medicare officials to focus on this populationthrough a cost-effective case management approach.

Rep. Peter Roskam (R-IL) says it's "a great way to start the day for any conservative who wants to get America back on track."

Sign up to start your free subscription today!

Sorry! Your form had errors:

About The Heritage Foundation

The Heritage Foundation is the nation’s most broadly supported public policy research institute, with hundreds of thousands of individual, foundation and corporate donors. Heritage, founded in February 1973, has a staff of 275 and an annual expense budget of $82.4 million.

Our mission is to formulate and promote conservative public policies based on the principles of free enterprise, limited government, individual freedom, traditional American values, and a strong national defense. Read More